A bad day for Mr Market

Article #575 by Edward Rizzo - Published Weekly

Almost 7 years ago I wrote an article titled ‘Introducing Mr Market’ in which I explained the parable about the imaginary investor called ‘Mr Market’ to describe the movements in share prices.

In his famous book ‘The Intelligent Investor’, Benjamin Graham, who is widely considered as the first exponent of value investing, explains that investors should look at investing in shares as buying a part of a business. The only difference is that instead of buying the entire business, an investor generally only buys a very small stake. Benjamin Graham says that investors should imagine that Mr Market would offer to buy someone’s share in the business or to sell his own share to them at an established price every day. At times, Mr Market’s idea of value seems to be justified by the developments and future prospects of the business. However, more often than not, Mr Market is either feeling very enthusiastic and optimistic or at times fearful and pessimistic. These dramatic mood swings result in a very volatile price quoted by Mr Market from one day to the next. In fact, some commentators define a share price as the value of a company multiplied by investor sentiment. While the value of a company tends to be rather stable, sentiment is very volatile.

Benjamin Graham argued that this irrational behavior by Mr Market provides opportunities for wise investors. Such investors should be happy to sell their stake to Mr Market when he quotes a very high price and should be willing to buy Mr Market’s shareholding when he quotes a low price.

However, the true value of the business should be based on an analysis of the company’s financial statements, the company’s business strategy and its investment metrics as well as the macroeconomic conditions rather than on the price quoted by Mr Market on a daily basis.

Benjamin Graham used the parable of Mr Market to demonstrate the point that a wise investor ought to choose investments based on their fundamental value rather than on the opinion of other investors or the general direction of the markets. However, market fluctuations should not be ignored as they can prove to be a valuable indicator of investor euphoria or investor pessimism. In fact, Benjamin Graham stated in his book that market fluctuations “provide an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance significantly”.

A parallel can be drawn with the property market. If someone offers you 25% less for your house compared to what would have been offered say 2 months earlier, you will reject the offer and hold on to your property asset. You would justifiably wait until the right offer comes along hoping to obtain what you regard as the fair price. However, if the neighborhood starts to deteriorate, the value of your house should be lower. If at this point in time someone offers a price which is more in line with your adjusted value, you should sell your property. Investing in shares should be done along the same principles.

This is precisely the philosophy adopted by the legendary investor Warren Buffett who has produced excellent returns for his fellow shareholders in Berkshire Hathaway. In fact, it would indeed be interesting to monitor the movements in his portfolio during the final quarter of 2018 when equity markets declined sharply.

I thought of writing about this topic once again following the reaction by several individuals to the steep decline in some share prices in Malta on 16 January 2019. It may be coincidental that on the same day a number of equities suffered sharp losses on thin volumes. The lack of support in the market in certain equities that may have led to such declines on low trading activity is possibly due to the significant liquidity being channeled into the current Initial Public Offering of BMIT Technologies plc which is the largest IPO in Malta since 1996.

While I am in no way seeking to opine on the intrinsic values of certain shares, I thought of highlighting the movements in two share prices in particular to relate this to the philosophy of traditional value investors and the parable of Mr Market. On 16 January, the equity of Simonds Farsons Cisk plc tumbled by 9.7% to €7.90 on volumes of only 2,051 shares resulting in a decline in overall market capitalisation of €25.5 million. Moreover, the share price of Trident Estates plc shed 10.8% to €1.32 on volumes of 2,851 shares resulting in a decline in overall market capitalisation of €4.8 million.

Incidentally these two companies were not listed independently prior to January 2018 and formed part of the overall Farsons Group. However, they are very different businesses indeed and it is worth commenting about the way several individuals may have reacted to the sharp share price declines seen on 16 January.

Simonds Farsons Cisk operates in the food and beverage sector with its core business being the manufacturing and sale of beer and other beverages. Although it is true that the share price of Farsons had been rising for several months, the 9.7% decline on a single day was purely due to market circumstances and investor sentiment rather than a change in the business dynamics.

Trident Estates plc owns a number of properties and the company is currently undergoing a major development of the Trident Park in Mriehel involving the conversion of the old bottling factory and stores into a modern office complex housing over 15,000 sqm of offices, conference facilities and car parking facilities for circa 700 vehicles. Since the company is mainly currently involved in property development activities, the main financial metric that an investor should track is the net asset value. The share price volatility of Trident since its listing in January 2018 actually provides a clear example of Mr Market’s erratic behavior from one day to the next. The shares of Trident were allotted to all shareholders of Farsons as part of a ‘dividend in-kind’ of €1.24 per share. Shortly after the shares were listed, the price jumped to a high of €2.00 before dropping back to €1.27. Recently, the share price rose again to the €1.55 level and after dropping by 10.8% on 16 January to €1.32, the equity eased further to the €1.28 level. This intense volatility in the equity surely does not reflect the changing circumstances of the company’s property portfolio and the ongoing development of the Trident Park project.

Before reacting quickly to sharp movements in share prices (in both directions), investors should consider the overall dynamics of the company in question and try to understand whether the company’s financial strength is actually improving or deteriorating as a result of a change in circumstances or business developments. The annual reporting season which commences in less than three weeks’ time will provide an opportunity to obtain updates on the financial strength of all the companies listed on the regulated main market of the Malta Stock Exchange. Hopefully, apart from the customary public announcement, most companies will also convene meetings with financial analysts to explain the financial statements in further detail and provide an update on the company’s business strategy in order to grow shareholder value.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon.

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